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Economic Substance Regulations (ESR) in the UAE
As part of the UAE’s commitment as a member of the OECD Inclusive Framework, and in response to an assessment of the UAE’s tax framework by the European Union Code of Conduct Group on Business Taxation, the UAE issued Economic Substance Regulations (Cabinet of Ministers Resolution No. 31 of 2019), (the “Regulations”) on 30 April 2019. Guidance on the application of the Regulations was issued on 11 September 2019 (Ministerial Decision No. 215 of 2019), and Cabinet Decision No. 58/2019 on the Determination of Regulatory Competencies lists the Regulatory Authorities tasked with the administration and enforcement of the Regulations. Amendments to the Regulations were made by Cabinet of Ministers Resolution No. (57) of 2020 on 10 August 2020, and updated Guidance was issued on 19 August 2020 (Ministerial Decision No. (100) of 2020 The Regulations require UAE onshore and free zone companies and certain other business forms that carry out any of the defined “Relevant Activities” listed below to maintain and demonstrate an adequate “economic presence” in the UAE relative to the activities they undertake (“Economic Substance Test”).
Relevant Activities:
- Banking Business
- Insurance Business
- Investment Fund management Business
- Lease – Finance Business
- Headquarters Business
- Shipping Business
- Holding Company Business
- Intellectual property Business (“IP”)
- Distribution and Service Centre Business
The Regulations apply to financial years commencing on or from 1 January 2019. Entities that are within the scope of the Regulations are required to submit an annual Notification form to their Regulatory Authority and complete and submit to the same Regulatory Authority an Economic Substance Report within 12 months from the end of their financial year (e.g. 31 December 2020 for entities with a financial year ending 31 December 2019).
An entity is not required to meet the Economic Substance Test and file an Economic Substance Report for any financial period in which it has not earned income from a Relevant Activity or if it meets the conditions for being exempt. A Notification form will need to be submitted regardless. Failure to comply with the Regulations can result in penalties, spontaneous exchange of information with the Foreign Competent Authority (as defined in Article 1 of the Regulations), as well as other administrative sanctions such as the suspension, revocation or non-renewal of the entity’s trade license, or permit.
Reportable Financial Year
A Licensee is subject to the requirements of the Economic Substance Test from the date on which it starts conducting the Relevant Activity, or for financial periods commencing, on or after January 1, 2019, where Licensee was carrying out the Relevant Activity even before the date from which the Regulations become applicable in the UAE.
For example, if a UAE-based business has a financial year of January 1, 2019 to December 31, 2019 then its first assessable period in connection with the Economic Substance Regulations will be January 1, 2019 to December 31, 2019.
In case, the financial year of the UAE-based business is from April 1, 2019 to March 31, 2020 then the first assessable period for the UAE business would be from April 1, 2019 to March 31, 2020. There would be no need for the business entity to comply with Economic Substance Regulations for the financial period from January 1, 2019 to March 31, 2019.
Who is Exempt from Regulations?
UAE registered businesses that get an exemption from demonstrating economic substance are as follows:
- Businesses that are directly or indirectly owned by a UAE government (Emirate or Federal Level) or a government institution. The government ownership in registered UAE businesses must be at least 51% or more.
- Businesses that undertake a Relevant Activity but do not generate any income from it during a financial period are not required to file an Economic Substance Return for that specific financial period. However, such businesses are still required to notify the relevant regulating authority regarding whether it undertakes a Relevant Activity or not.
Notification and ESR Return Filing Regulations
All business entities operating within the UAE are required to notify their relevant regulating authority whether they undertake a Relevant Activity or not.
UAE registered businesses that engage in a Relevant Activity must satisfy all the economic substance requirements specified in the regulations and otherwise, and file an economic substance return with the same regulating authority within one year from the end of their financial year/period.
If a registered business falling within the scope of the Regulations does not undertake a Relevant Activity during a financial period then in such a scenario that business would not be required to notify and file an Economic Substance Return with the relevant regulating authority for that financial period.
Failure to comply with the Regulations by an eligible business entity will result in fines and penalties, potential suspension, non-renewal, or revocation of its registration.
Fines and Penalties for Non-Compliance
If a registered UAE business falling within the scope of ESR fails to notify the relevant regulating authority then the business entity would be required to bear the penalty of AED 10,000 to AED 50,000.
If a business entity fails in providing complete or accurate information in the context of the Economic Substance Regulations Reporting, then that business entity would be deemed as a failure in demonstrating Economic Substance in the UAE in addition to bearing a penalty falling in between AED 10,000 to AED 50,000.
If a business entity fails in demonstrating sufficient Economic Substance in the UAE for a relevant financial year and if it is the business entity’s first failure, then it would be charged a penalty between AED 10,000 to AED 50,000. In addition, the information will be exchanged with a competent authority on the following:
- Parent company;
- Ultimate parent company; and
- Ultimate beneficial owner
If a business entity fails in demonstrating Economic Substance for a second consecutive year, then the information will be exchanged as mentioned above in addition to the following:
- The entity would be charged a Penalty of AED 100,000 to AED 300,000 and
- The commercial license would be withdrawn, suspended, or not renewed.
How Can CGMA assist?
We at CGMA have a team of highly competent and qualified professionals that will help you in determining whether you are affected by the Regulations and guide you regarding the actions that should be taken to ensure compliance with the Economic Substance Regulations.
- Assessment regarding whether you fall within the scope of the Regulations
- Assessment whether you are in a position to satisfy the Economic Substance Test
- Notification filing assistance